In Uncategorized on 11/10/2011 at 16:44

And, “Gude faith, he maunna fa’ that!”

Two for one today. We start with Benny Nipps, 2011 T. C. Mem. 267, filed 11/10/11. Benny was ignorant when he inherited his cousin Larry’s IRA. He told Landmark Bank, where Larry stashed his cash, to give him the money. Benny deposited it in a brand-new IRA he started for himself. Unhappily for Benny, he immediately took the money out of his brand-new IRA.

As he inherited the IRA and wasn’t his cousin’s wife, Section 408(d)(3)(C) prevents rollover. However, under caselaw, the door is open to a trustee-to-trustee if Benny never got his hands on the money. Yielding to temptation, Benny took the money and didn’t run fast enough.

Benny owes tax on the money, but does he owe Section 6662(d)(1) substantial understatement penalty? As Benny clearly understated more than $5K and 10% of the tax required to be shown (the five-and-ten penalty), it looks like a slam-dunk for IRS.

Judge Paris, however, looks at the forms the bank had Benny sign when he took over Larry’s IRA. Benny could have reasonably believed that the bank was going to withhold whatever Benny owed, based on the documents and Benny’s education, experience and knowledge. Benny also didn’t bother to pay tax on his Social Security, but that’s left for a Rule 155 jump-ball.

Although Benny’s exact educational, experiential and knowledge qualifications and attainments aren’t spelled out, Judge Paris seems to conclude that Benny isn’t the swiftest dune buggy on the beach, or, more elegantly: “Petitioner, who lacked knowledge and experience in tax law, reasonably believed that the correct Federal income tax would be withheld by Landmark Bank. The beneficiary notice stated that Landmark Bank would withhold Federal income tax unless petitioner elected otherwise. Petitioner did not elect out of this withholding. He reasonably relied on Landmark Bank’s lack of withholding of Federal income tax as basis for his position that the distribution was not taxable. While petitioner is liable for the tax, as the payor’s withholding obligation does not excuse taxpayers from the duty to report and pay the resulting tax, the Court finds that he had a reasonable basis to believe that the correct withholding would occur and that absent that withholding, the amount was not taxable.” 2011 T.C. Mem. 267, at p. 7.

So Benny dodges the Section 6662 penalty, as it regards the IRA. For Social Security, Judge Paris seems to decide that Benny should know better. So ignorance is partially bliss.

Now for the good faith, and why IRS “maunna fa’ that”, as Scotland’s greatest famously remarked. It’s Timothy John Karlen and Jennifer Karlen, a “don’t quote me” Section 7463, 2011 T. C. Sum. Op. 129, filed 11/10/11.

TJ set up three Section 529 college savings accounts, one for each of his and J’s children. As Dixie’s poet famously remarked, “By’n by hard times comes a-knocking at the door”, so TJ loots the kids’ account to pay their household expenses. Checks in hand, TJ heads for the bank, while J tearfully begs him to spare their innocent babies’ future. TJ relents, endorses the checks and mails them back to the trustee of the kids’ Section 529s.

Now, since all TJ could do by law was either fund a new 529 for each child with the proceeds or open a new 529 for another member of his family who would qualify as the beneficiary of a Section 529, he owes the $1318 income tax deficiency. And he candidly testified he never intended to do a rollover when he got the checks. A repentant sinner saved by his wife’s tears, and an honest witness on a trial–proves the old saying–“No good deed goes unpunished”–totally.

Special Trial Judge Armen, a man with a heart, holds the checks are gross income to TJ and J, but states the taxable redeposits will increase the basis in the accounts, thus eventually lowering any tax on future distributions. As they say in Texas, “How nice!”

But STJ Armen goes further, and forgives the Section 530(d)(4)(A) 10% additional tax on disqualified distributions. “Congress granted tax-exempt status to education investment accounts ‘To encourage families and students to save for future education expenses’. S. Rept. 105-33, at 16 (1997), 1997-4 C.B. (Vol. 2) 1067, 1096; H. Rept. 105-148, at 323 (1997), 1997-4 C.B. (Vol. 1) 319, 645. To impose a 10-percent additional tax upon petitioners given the unique facts in this case ‘would be like throwing salt into a wound.’ Larotonda v. Commissioner, 89 T.C. 287, 292 (1987). Although the distributions received are includable in petitioners’ gross income, ‘doubt exists in our mind as to whether the * * * [additional tax] was designed to cover the situation involved herein.’ Id. We are mindful that ‘A particular construction must not produce inequality and injustice if another and more reasonable interpretation is possible.’ Grier v. Kennan, 64 F.2d 605, 607 (8th Cir. 1933) (citing Knowlton v. Moore, 178 U.S. 41 (1900)). Because petitioners never used the distributions and instead immediately returned the distribution checks to the NC 529 Plan to save for their childrens’ future educational expenses, “we think it judicious to resolve this issue in favor of’ petitioners given their unique situation. See Larotonda v. Commissioner, supra at 292. Consequently, we hold that the 10-percent additional tax does not apply.” 2011 T.C. Sum. Op. 129, at pp. 7-8.

Good faith sometimes mitigates the blow.

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